09.15.2014 0

House Republicans push to make subprime, higher risk lending easier?

money-bombBy Robert Romano

By now, the causes of the mortgage crisis that nearly wrecked the global economy in 2007 and 2008 are common knowledge. Too many high risk loans were made, too much credit boosted housing prices to the moon, too much leverage was taken on by financial institutions, and then, when the bubble came crashing down, not enough capital was held to cover the inevitable losses stemming from millions of foreclosures.

As a result, mortgage giants Fannie Mae and Freddie Mac had to be placed under government conservatorship. Numerous private firms that bet poorly on housing like Bear Stearns or Merrill Lynch or Countrywide had to be folded into larger firms. Insurance giant AIG that had guaranteed privately issued mortgage-backed securities had to be temporarily bailed out by the Federal Reserve. Trillions of dollars of emergency lending programs both by the Treasury and Federal Reserve, plus trillions more of quantitative easing, were used in tandem to clean up bank balance sheets.

On the personal side, millions lost their jobs and their homes, and millions more were stuck in homes worth less than the value of the mortgages, freezing up significant parts of the housing market. Prices continued to drop before finally reaching a bottom in 2011.

Overall, the perils of debt deflation were fully on display. One might think that the lesson learned would be not to do it all over again. Not to engage in stupid, risky lending backed up by a near limitless supply of government. Not to use housing valuation inflation as the primary means of expanding wealth. Not to depend on debt creation to generate economic growth and new jobs.


Now, seven years after the crisis began in the summer of 2007, demand for new credit remains low by historical standards. The amount of labor force displacement as a result of the initial recession remains quite elevated. Home values, although having recovered somewhat from the market bottom, have stalled right along with home sales. To the extent that we had a recovery, it looks like it has pretty much run its course. Time for another cooling.

After all, the economy moves in cycles, averaging a recession once every 6 to 7 years since 1947. We’re pretty much due for another downturn.

So, with housing, credit creation, and thus the economy moving into another correction period, predictably, policy makers want to find a way to keep the bubble blowing upward for a little while longer.

For example, recently the House Financial Services Committee, run by Republicans, sent H.R. 5148 to the floor of the House. It eliminates mandatory appraisals by an independent appraiser in higher risk mortgages of homes valued $250,000 or less. Those are mortgages with higher interest rates ranging from 1.5 to 3.5 percentage points higher than prime. By definition, then, these “higher risk mortgages” are subprime.

The legislation does not apply to prime mortgages. So for the vast majority of legitimate loans, a mandatory appraisal will still be necessary. The exception will be subprime. But is that a good idea? Aren’t higher risk mortgages the ones where an honest valuation is the most important?

Community banks want the bill to pass. They say a $450 mandatory appraisal is “a significant expense for home borrowers” that is “rigid and expensive appraisal requirements that unnecessarily escalate the cost of mortgage credit,” according to a letter from the Independent Community Bankers of America.  They say they would do their own appraisals without homebuyers needing to purchase the home. They also claim that because the bill requires the bank hold onto the loan for 3 years, this will disincentivize stupid loans from being made.

In truth, 3 years is really not that long of a time, and the foreclosure process itself can take much longer to complete in some cases. Besides, just because a person only goes delinquent after 3 years does not mean it wasn’t a stupid loan to begin with.

Also, in the great scheme of things, a few hundred dollars for an independent appraisal for homes selling for up to $250,000 is not that big a deal. One realtor I spoke to called it “small potatoes.” In other words, whether appraisals are included in the closing costs will have little to no bearing on whether a home sale takes place.

Finally, banks doing their own appraisals could have a conflict of interest if the implicit goal is to boost property values, landing larger principal on the mortgages, and increasing their bottom line on interest payments. Wasn’t one of the lessons of the housing bubble that home values were out of control?

So why remove independent appraisals for the riskiest loans that were the tip of the spear in the last crisis?

Rep. Blaine Luetkemeyer (R-Mo.), the bill’s sponsor, believes the change is necessary for rural communities, where a supposed lack of local appraisers requires bringing in appraisers from miles away to get houses to go to closing. As a result, escalating closing costs are being passed on to consumers.

But, if the bill is supposed to be simply for rural areas where there are no appraisers, then why does it encompass all subprime loans, which naturally will be concentrated in suburban communities, not family farms? What about prime loans in rural areas? Why do they still need independent appraisals? It doesn’t add up.

And yet, if this one has you scratching your head, it shouldn’t. This is reflective of a larger problem, that is, the need for ever-expanding debt to grow in our finance-based economy. When the government perceives not enough new loans are being created, and market conditions are too cool, the natural response to get things moving is to make it easier to make the loans. In this case, by removing the need for appraisals for higher-risk loans.

While both parties may disagree on the means, H.R. 5148 passed out of committee on a party line vote, they do both appear to agree on the ends. This is seen on the left with the push for so-called community reinvestment, that is, loans being given for low-income families in higher risk neighborhoods. Or in the push to punish lenders who do not. It is seen in calls for more banks to give out Federal Housing Administration (FHA) loans, even though they are already widely available.

Or, in the Federal Reserve’s 30-year push to drive down interest rates until now, the Federal Funds rate is near-zero. Or to include more low-income lending in Gramm-Leach-Bliley as a condition for passage of the 1999 financial reform law. Or the expansion of Fannie Mae and Freddie Mac’s affordable housing goals under the Clinton and then Bush administrations. And on and on.

The point is, policy makers don’t see any other way. If new loans are not being made in our finance-based economy, the whole thing shuts down. But it’s a catch 22. If too many crappy loans are made, it falls apart, too. So, now what?

Robert Romano is the senior editor of Americans for Limited Government.

Copyright © 2008-2024 Americans for Limited Government